ADVERTISEMENT

How BOJ Policy Is Driving Taper Speculation: QuickTake

How BOJ Policy Is Driving Taper Speculation: QuickTake

(Bloomberg) -- When the Bank of Japan reduced its purchases of government bonds in January, some investors saw it as another sign that the bank was scaling back its massive monetary stimulus program. The BOJ disagrees with that interpretation, but in February the bond market pushed yields to near the upper limit of what the bank’s targeting. While the BOJ was able to drive them lower with an offer to buy an unlimited amount of bonds, not everyone is convinced that it can continue with its current stimulus when the Federal Reserve is raising rates and the European Central Bank is starting to talk about when to end its own bond purchases. The BOJ gave clearer direction in March when Governor Haruhiko Kuroda said the central bank will start thinking about how to exit its stimulus program around the fiscal year beginning April 2019.

1. Why is the BOJ buying bonds?

To push inflation up to 2 percent. Kuroda believes almost two decades of deflation discouraged risk-taking activities among businesses and households, resulting in protracted economic stagnation. By buying hundreds of billions of dollars worth of bonds every year, the BOJ is keeping interest rates low, thereby stimulating economic activity, boosting investment in riskier assets and adding to demand in the hope of stoking inflationary pressures.

2. What’s happened to those purchases over time?

The central bank’s guidance has been that it increases holdings of government bonds by about 80 trillion yen a year, although the actual pace is far below that. The BOJ’s bond purchases have been steadily falling since the central bank cut a key policy interest rate to below zero in January 2016. The drop has quickened since the introduction of yield-curve control policy in September that year. And the divergence sparked discussion that the BOJ is actually reducing stimulus, possibly as the first stage to normalizing monetary policy.

3. What does the BOJ say will happen with those purchases?

Despite the fall in buying, the BOJ has been successful in managing the nation’s yield curve, even with the rise in U.S. Treasury yields putting upward pressure on Japanese rates. Kuroda has said a number of times that a decrease in the amount of government debt available for purchase means that the BOJ could get the same easing effect by buying less debt. He has also said that any changes in the central bank’s day-to-day bond buying are dictated by the market and don’t imply a future policy stance. For the moment, the bank continues with its contradictory stance on bond purchases -- on the one hand saying that it will aim to increase its holdings by about 80 trillion yen a year, on the other hand that it will buy enough to keep 10-year yields at about zero. Longer term, Kuroda said in March he expects inflation will reach the BOJ’s 2 percent target in around fiscal 2019. He said “it’s logical that we would be thinking about and debating exit at that time too.”

4. What does the market think will happen? And why? 

An improving Japanese economy, the gradual reduction in the BOJ’s bond buying, ongoing policy tightening by the Fed and discussions on an eventual exit from stimulus by the ECB have all compounded speculation that the BOJ will start to contemplate more openly how to normalize policy, either by unwinding quantitative easing, raising rates, or both. With the central bank owning more than 40 percent of sovereign debt, there is also concern that the BOJ will crowd private investors out of the market. Countering this speculation about normalization are the nominations of Kuroda for a second term and committed reflationist Masazumi Wakatabe as his deputy. The choices point to continuity in policy, with an implicit message that Japan will do what it takes to reflate the economy, according to Bloomberg Economics.

5. What happened in January?

The BOJ cut purchases of bonds maturing in more than 10 years at a regular operation on Jan. 9. Although a gradual reduction had been taking place before that, some traders speculated that the reductions were a form of unacknowledged taper -- the term used to describe how the Fed gradually wound down its own program of bond purchases. Their actions helped trigger a month-long rally in the yen on the back of broad dollar weakness, although some BOJ-watchers argued that they jumped the gun.  

6. What happened in February?

In response to bond yields pushing up toward 0.1 percent, the BOJ boosted purchases of five- to 10-year bonds at its regular operation on Feb. 2 and separately offered to buy an unlimited amount of 10-year notes at a fixed yield of 0.11 percent. The latter is a tool the central bank introduced in 2016 along with its yield-curve control policy, and is more about signalling the market than actually buying bonds. On three of the four occasions the BOJ has used this tool, it didn’t actually buy anything. By setting the yield higher than the market rate, the bank is offering a price lower than what the bonds are actually trading for, in effect, setting a ceiling on yield.

7. Why does it matter what happens?

The BOJ’s bond purchases have long-term ramifications not only for Japan but also globally. Japan is the world’s biggest creditor - its net $3.2 trillion international investment position is 44 percent bigger than Germany’s and almost twice that of mainland China’s. A reduction in the BOJ’s stimulus, and a subsequent rise in yields, could funnel part of Japanese portfolio investments back into the nation’s bonds and decrease demand for debt and equities overseas. It would also have implications for the yen’s exchange rate. Right now, interest rates in Japan are much lower than in the U.S. If Japanese yields drift up, that could mean a stronger yen. A stronger currency could make imports cheaper and reduce inflation. The central bank doesn’t openly admit it wants a weaker yen, but Kuroda did say in May 2013 that the BOJ’s asset purchases are expected to prompt domestic investors to shift from government bonds to riskier and higher-yielding assets, including foreign currency-denominated bonds.

8. What should you watch going forward?

Due to the heightened market interest in Japan’s monetary policy, any increase or decrease in the purchase amounts at the regular bond-buying operations could trigger a jump or slide in the yen, even though Kuroda said such changes don’t have any policy implications. The central bank reduced purchases of debt due in more than 25 years on Feb. 28. Investors should also watch the timing and details of the BOJ’s fixed-rate operation as clues to assess the central bank’s tolerance for higher yields. For now, 0.11 percent is seen as the ceiling.

9. How does the BOJ conduct bond-buying operations?

Every month, the BOJ publishes a schedule of its planned purchases in the coming month. In each auction, financial companies submit desired yields at which they seek to sell government bonds to the central bank. The BOJ accepts offers that have the highest yield spreads over benchmark rates till it buys the desired amount. The benchmark rates are market rates as of 3 p.m. Tokyo time the previous day, compiled by the Japan Securities Dealers Association.

The Reference Shelf

  • Reaction to Kuroda’s comments on exiting stimulus.
  • A Bloomberg View column explaining why the BOJ is missing a chance to taper off its bond stimulus.
  • A QuickTake Q&A on BOJ’s yield curve control.
  • Bloomberg’s Chris Anstey is interviewed about the BOJ’s "low grade war” with the markets.

--With assistance from Grant Clark

To contact the reporters on this story: James Mayger in Tokyo at jmayger@bloomberg.net, Masaki Kondo in Singapore at mkondo3@bloomberg.net.

To contact the editors responsible for this story: Tan Hwee Ann at hatan@bloomberg.net, James Mayger

©2018 Bloomberg L.P.